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Earlier this month, the Supreme Court announced that it will review the scope of Bankruptcy Code section 546(e)’s safe harbor provision. Section 546(e) protects from avoidance those transfers that are made “by or to (or for the benefit of)” a financial institution, except where there is actual fraud. The safe harbor is intended to ensure the stability of the securities market in the event of corporate restructurings.

Now the Supreme Court is poised to determine whether this safe harbor precludes avoidance of a transfer made by or to a financial institution, where the financial institution is merely a conduit with no beneficial interest in the property transferred.

In July 2016, the Seventh Circuit held that the safe harbor does not protect transfers that are “simply conducted through financial institutions (or other entities named in section 546(e)), where the entity is neither the debtor nor the transferee but only the conduit.” FTI Consulting v. Merit Management, 830 F.3d 690, 691(7th Cir. 2016).

In this case, Valley View Downs, LP acquired the shares of a competitor for approximately $55 million, in which Merit had a 30% ownership interest. Valley View’s business strategy failed, and it filed for bankruptcy protection. Subsequently, the trustee sought to recover the $16.5 million paid to Merit for the purchase of the shares for the estate. While neither Merit nor the debtor were qualifying financial entities subject to the safe harbor of 546(e), the payment passed through two banks prior to being transferred by the debtor to Merit. The Seventh Circuit determined that the statutory language was vague, and that Congress intended to protect only qualifying financial entities from avoidance, but not to protect entities that are not qualifying financial entities simply because a transfer passed through a financial intermediary.

The Seventh Circuit joined the Eleventh Circuit in so holding, while the majority of circuits – the Second, Third, Sixth, Eighth and Tenth have held that the 546(e) safe harbor does shield transfers that pass through a financial institution as merely a conduit. The Supreme Court is now expected to resolve this circuit split.

In a similar dispute, involving the Tribune Company LBO and subsequent bankruptcy, the Supreme Court has not yet granted nor denied the petition for certiori. In that case, which Distressing Matters discussed here, the Second Circuit held that the safe harbor prevents creditors from recovering under state constructive fraud theories when shareholders receive distributions under securities contracts effectuated through financial institutions. Although the Tribune noteholders sought Supreme Court review of the Second Circuit’s ruling in September 2016, it appears that the Court is holding off on review of that particular issue for now. Stay tuned!

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